At long last stock market volatility returns due to rising interest rates. We’ve now seen a more than 60% increase in the risk free rate since its 2012 bottom and things are starting to get hairy. I’ve been wrongly waiting for a pull back since the beginning of May so it’s good to finally get some sanity back in the markets again.
Nobody knows whether rates will continue to move higher from current levels. However, it’s good to layout a what if scenario so we can be better positioned.
Rising interest rates do the following:
* Makes mortgages more expensive. The window to refinance at all time lows has passed.
* Makes car loans more expensive. One shouldn’t be borrowing money to buy a depreciating asset anyway, so all is good.
* Increases credit card interest rates to even more egregious levels. Nobody better have revolving credit card debt unless they are a financial masochist.
* Increases student loan interest rates, depending on what type of government subsidies you receive.
* Makes the stock market less attractive given the opportunity cost to own securities has increased. One of the main reasons why I aggressively invested in equities in 2012 was because the S&P 500 dividend yield was greater than the 10-year yield.
* Cools off the housing market as homebuyers are now hit with an increase in prices from a year ago and rising mortgage payments.
* Slows down consumption growth, which is the main driver for GDP growth in the Y = G + I + C + NI equation.
* Theoretically increases your savings rates and CD rates, but banks will move like molasses to adjust so don’t bet on anything great for a while.
* Leveraged buyouts will decrease at the margin due to more expensive debt financing.
* Makes bonds look more attractive given higher yields.
* Strengthens the US Dollar vs a basket of major foreign currencies.
* Makes you reflect on what’s next.
It’s important to realize that a rising interest rate environment often reflects underlying strength in the economy as the demand for money increases. Money demand increases due to better employment levels, higher wages, positive growth expectations and a host of other factors. It’s the short term adjustment, which which can be tricky to maneuver.